Staples Inc (NASDAQ:SPLS) enters 2016 in a familiar predicament. The company remains profitable, but the office-supply industry is drying up. In the digital age, office supply retail just isn't as useful as it once was, and products like paper and printer ink are becoming obsolete.
The company and its rivals know this. That's why Office Depot (NASDAQ:ODP) and Office Max merged in 2013, and Staples now seeks to combine with Office Depot, joining the No. 1 and No. 2 office supply retailers in the U.S.
Shares of Staples are trading at a 52-week low as the chances of the deal passing regulatory muster seem to be slim, but the results of the merger attempt should largely determine Staples' fate in 2016.
Where the merger stands today
Almost a year ago, Staples announced its acquisition of Office Depot for the equivalent of $11 per share, a 44% premium of its prior-day trading price. However, the Federal Trade Commission has twice blocked the deal, even as Staples offered to divest $1.25 billion in valuable commercial contracts. The FTC said in December that the merger would significantly curb competition in the industry, even though Staples' leadership is now being challenged by the like of Amazon.com, Wal-Mart Stores, and Costco Wholesale.
Earlier this month, an FTC lawyer said settlement talks are continuing, and a federal court hearing is scheduled in March, which could ultimately determine the fate of the merger.
Meanwhile, a source quoted in the New York Post said, "the chances of a settlement are near zero."
Staples' stock is clearly sensitive to merger news as the stock fell 14% on December 7 as the FTC sued to block the deal. Staples' stock is now trading at 13-year lows, indicating how far the company has fallen.
If a deal doesn't go through
Without a merger, it's hard to see Staples' financial picture improving. Though its commercial division is generating slight improvements, performance in its retail segment continues to worsen. In its most recent quarter, North American retail sales fell 8%, while comparable sales were down 2.2%, and operating income in the division was down 8%. International continues to fall as well. The decline in comparable sales came in spite of the company closing 225 underperforming stores, or 12% of its North American base, indicating that even its healthy stores are losing sales. Earnings per share in the quarter fell from $0.34 to $0.31.
The best argument for investing in Staples may be its juicy dividend yield of 5.3%. After all, the company is still amply profitable, and earnings are only declining slowly. The company is targeting $600 million in free cash flow this year, giving it a reasonable payout ratio of just 50%. However, management has not raised its dividend since 2013, and as long as sales and profits are falling, the payout risks being slashed or thrown out altogether at some point in the future. That likely won't happen this year, but during the recession, Staples cut its quarterly dividend from $0.32 to just $0.08.
With the Office Depot merger appearing increasingly unlikely, and Staples unable to stanch its comparable sales decline, 2016 should be Staples' worst year in some time. The stock is trading in the single digits for the first time since 2003, and there's little reason, other than a merger approval, to expect it to bounce back, especially considering the rampant market selling thus far in the new year.
Expect more store closures, which will come with or without a merger, and for comparable sales to keep falling. The paradigm has shifted, and Staples' footprint will continue to disappear.